Tuesday March 17: Stocks Fall Ahead of Fed Meetings

Stocks fall ahead of FOMC meeting as investors weigh the Fed’s interest rate decision. The S&P falls .3% to 2,074 and the Dow loses .7% to 17,849. The S&P has fallen 2% since March 2 as investors speculate that the strengthening dollar will have a negative impact on corporate earnings. Housing starts fell in February, however this was offset by an increase in building permits which indicate the drop may be temporary. The VIX rises slightly to 15.66. Oil prices fall to $53.51 and $42.63 for brent crude and WTI respectively. The dollar index fell initially due to weak data, however finished slightly higher on the day. The dollar-euro finishes at $1.0591. Yields on the front end of the Treasury yield curve rise on the front end, and drop in the middle with the 2 year up two basis points and the 10 year down four basis points to 2.06%.

The dollar run appears stretched as the strength is not supported by the level of economic growth that has backed previous periods of similar price movements. If the strength of the currency begins to hurt U.S. growth and inflation, the Fed may delay monetary tightening which could hurt the dollar. The rise in the dollar is mostly due to policy divergence between central banks as opposed to positive structural economic shifts. To offset these concerns, the stronger dollar has lowered commodity prices which could boost the economy going forward. A strategist from BoAML says that what we’re seeing is not a dollar rally, but the weakness in the euro is more prevalent. Given overall positioning in the dollar the market anticipates further strength and is therefore vulnerable to a delay in monetary tightening.

Asset managers have cut their holdings of U.S. equities to the lowest rate in seven years due to high market valuations ahead of tightening by the Fed. The massive injection of liquidity into the U.S. financial system through bond purchases and low interest rates have helped the S&P500 rise 250%, and many fear that this run may be over as accomodative policy draws to a close. According to a BoAML survey, nearly 25% of 168 global asset managers say U.S. equities are overvalued, which is the highest percentage since 2000. To compensate for their underweight U.S. holdings, European equity funds have experienced heavy inflows as the ECB begins their own round of easing.

Ray Dalio warns of a market slump similar to 1937 when the Fed finally raises interest rates. In a note to clients, the founder of Bridgewater Associates said that due to the potential for unintended negative consequences, he is avoiding taking large positions in certain financial markets. Similarly, head of the IMF Christine Lagarde warns of instability in emerging markets reminiscent of “taper tantrum” and the emerging market selloff in 2013. At the FOMC meeting on Wednesday, the Fed is expected to remove pledges to be patient when lifting interest rates and give further direction on when rates will first rise. Financial markets reflect expectations for the liftoff to occur in June or September however the appreciated dollar and some weaker than expected economic data have blurred the expectations slightly. In his letter, Dalio urges the Fed to proceed with caution and have a plan incase monetary tightening goes wrong. Many emerging market corporations have borrowed in dollars despite their lack of dollar revenues without expecting the dollar appreciation. As a result of his fears, Bridgewater is not assuming any concentrated exposure in the markets.

Some economists fear that quantitative easing in the ECB is supporting a bubble in bond markets as valuations begin to shift away from fundamentals. Others believe that the current low yields in Europe is supported by fundamentals considering stagnation, where the rate of innovation is slowing along with demand. It’s possible that investors have shifted their expectations about the scale and likelood of financial crises. For example in the past investors may have thought financial collapses to be a one-in-100 years event, however this expectation may be shifting to a one-in-50 or 25 years event. In addition the shift may be due to increased geopolitical risk. Both of these factors may contribute to interest rate levels seldom seen in the past. Yields in Europe may continue to fall as the ECB has stated it will continue to buy bonds even if yields are negative. As a result investors will continue to speculate on yields going further negative.

Tuesday March 17: Stocks Fall Ahead of Fed Meetings

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s